June 17, 2010

The Savings Conundrum -- Our Future?

Suppose you and I were young and loved the wilderness and by chance we both moved to a small, remote meadow where we lived in teepees not far from each other, bringing with us basic tools by which to get our living. Suppose not long after we arrived we found an old cache of golden stones in a nearby cave from prehistoric times, and divided them equally, so that we had 20 golden stones apiece.

Suppose you loved to garden and forage, and had tools and seeds, and that I loved to hunt and trap and fish.

Not long after we arrive, you might well begin to want some meat to go with your meals, and I would surely like to have some vegetables, fruits or nuts to go with my meat.

While the first time or two we might simply trade a few items in barter, soon it would likely happen a day would come when I had a large haul of fish and you might have only a few nuts and I might suggest that you simply give me 1 of your golden stones (a "goldie") as a token for future food which I might buy back from you on another day when you had more.

We would have an economy, not fundamentally different from the global economy, even with its exchange rates, central banks, factories and technology.

Soon we might well have typical prices for our goods. A fish might cost a goldie, and so might 2 potatoes.

Perhaps on an average day we'd exchange a goldie or two, and in a week, perhaps several would go back and forth. Eventually, seasonal patterns might show up, and over the years we might have habits of me buying more vegetables in the summer, and you more meat in the winter, so that in the summer you would have more goldies and by early spring I would have more goldies.

Now, suppose one day, after several years of a stable, productive economy, I decided I wanted to save goldies for the future. Suppose I went on a savings binge. To save, I begin buying less from you, keeping more of my goldies in the summer, and foraging some for myself.

At the end of the summer, when you would usually have had plenty of goldies to buy meat from me in the winter, you'd find you have much fewer.

You've experienced a big loss of income. And winter is coming on. You've been saving nuts and potatoes, but you know it's going to be a hungry winter.

In desperation, due to your reduced income you begin buying less meat from me during the fall.

Now my income is reduced also.

In sum:
a) I've had less vegetables than usual
b) your income was reduced
c) you are poorer, and now now must make due with less meat than usual
d) and therefore my income is now reduced also.

I saved, and no one borrowed that savings and put it back into the economy, and the result was an economic spiral downward.

You are hungrier. I am hungrier.

Unless I stop saving, or someone starts borrowing my savings and spending it, trade would decline week after week, as I withdrew more and more goldies from circulation. Most likely what would happen is that due to my reduced income, I would be forced to begin choosing whether to save another goldie or have vegetables to eat that week, or take on extra work to grow my own, so that I worked 16 hour days. Eventually, my savings rate would stall out and decline, in spite of my plan. Either I'd stop saving in order to get some rest and eat at least a few vegetables, or I'd stop saving because I no longer have any income left to save. Trade would either stop entirely or be maintained at a low, impoverished level.

This is ultimately the real thing that is behind the abstraction of the "worldwide savings glut" -- a great excess of global savings over the sum of global consumption and sensible investment.

It is economic decline, joblessness, even economic downward spiral.

The only difference between our meadow and the global economy that matters here is that in the global economy, the massive savers -- the Germans and the Chinese -- loaned their savings to the rest of the world into financial markets and mortgaged-backed securities so that the money went into house-price bubble countries whose bubbles were filled exactly by that excess of savings.

This massive credit delayed the downward spiral a savings glut must cause, but only to make the shift more sudden, so that the inevitable downward spiral was more like falling off a cliff (2009).

Unless the excess savers change course, this will touch everyone, and may well even slam those that have a lot of savings in every nation, because savings cannot earn interest or dividends of any significance unless the invested-into economies grow.

In nations like China, such investments can take many forms, including such basic needs as railways, health clinics, hospitals and schools. And in underdeveloped nations, investments could take almost unlimited forms.

Because we are afraid of the economic uncertainty, even those of us that wouldn't ordinarily hoard a great excess of savings are trying to save more rapidly now.

People in many advanced nations are demanding their governments reduce deficits at the same time that they themselves save more.

In other words, the savings glut is likely to grow again in proportion to the world economy. Conditions could soon be getting worse.

Unless good investments quickly ensue, the unused savings could indeed spiral the global economy, and that of most all nations, down into a great depression.

There is no long-term solution to this more general new psychology of hoarding short of creating renewed confidence in most nations where fear of the future holds sway. For instance in China this would take many forms, including visibly increasing the future economic security of retirees so that Chinese households would feel more confident about spending part of their large savings now.

Around the world, changes are needed now, before our global crisis deepens.


  1. I can agree to the fact that the massive credit delayed the downward spiral caused by a saving glut. But how did it eventually happen? If credit was able to stall the downward spiral at the beginning, why it was not able to do so at for ever?

    These are the more important questions which answers have to be sought rather than attributing the downward spiral to a global saving glut alone and stop at that.

  2. Sunil, the effect of the world-wide savings glut was to make easy credit (low interest and less demanding loan qualification requirements) available in several nations. The effect of easy money, a flood of money, is that intrinsically valuable and limited goods like housing, higher education, medical care go up in price rapidly, since buyers compete to buy them with the easy money.

    As housing went up in price, people started to rationalize the price inflation, and believe it would continue -- housing would always go up -- thus reinforcing the inflation. This allowed mortgage originators to sell the idea of zero-down payment mortgages, based on the expectation that in a foreclosure, the house would sell for enough to protect those holding the mortgage paper. Investors would be able to get their money back even if there were many foreclosures.

    Of course this was wrong.

    In short, it was a "credit bubble," which is the other face of a savings glut.

    What happened next was that as loans were extended to all sorts of buyers unable to make the payments, the default rate began to rise, and then the credit rating agencies had to recognize that the securitized mortgages (investment paper) wasn't as AAA as they had rated it previously. Once that recognition occurred, the whole house of cards collapsed, since the process of selling the securitized paper became untenable.

    There were no more buyers of mortgage paper, then the easy money dried up, then there were no more buyers of over-priced houses.